I like the idea of a cutoff level, and it probably should be pretty small so you don’t have to worry about when to change the font color from white to dark.
I also agree with zblesk-- if someone had that many sublevels they’d have to be doing all their navigation by searching terms or tags anyway, so colors wouldn’t be useful there and they would likely just turn the coloring feature off.
I like the first mockup better too. Let me make one more, sampling those exact colors (as I noted I think I made the second one too dramatic in the color shift).
